The Negative Effects of Low Oil Prices

Chris Versace
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Posted: Jan 08, 2015 12:01 AM
The Negative Effects of Low Oil Prices

Everyone rejoiced last year, not because of world peace, which would be nice, but because of the sharp drop in at-the-pump gas prices. According to the Energy Information Administration, average at-the-pump gas prices fell about 29% from the late June 2014 high to $2.22 per gallon on Dec. 29. AAA, which shared that gas prices fell during the prior 100 days, has reported gas prices hit a national average of $2.20 per gallon earlier this week, marking the lowest level since May 2009.

Proving that pennies do add up, AAA estimates that Americans saved about $14 billion on gasoline in 2014, compared to 2013. With annual gas prices averaging $3.34 per gallon in 2014 vs. current gas prices, it’s looking pretty good that we will be saving even more in 2015, as oil prices ratcheted even lower again this week.

Amazing to think that back in October the Federal Reserve put banks through their paces with a stress test that included a scenario of oil hitting $110 per barrel. Once again, I am amazed at how out of touch the Fed seems to be with market forces.

As my father was fond of saying, “when you spit up, it has to come down” – and while that can be viewed a few ways, it relates to this conversation as a reminder that, while we are feeling our pockets a little heavier or our credit card bills a tad lighter thanks to falling gas prices, there is a dark side to it all.

I hate to be Debbie Downer, but while you and other Americans will continue to reap the benefits of lower oil and gas prices, the effect has been different for oil companies such as Halliburton (HAL) and BP (BP). What’s been described by oil industry executives as a “Darwinian adjustment” has companies like those cutting jobs. Models from the Federal Reserve Bank of Dallas indicate that if crude oil remains around $55 per barrel, Texas could lose 128,000 direct and indirect energy jobs by mid-2015. Big independent producers including Marathon Oil (MRO), ConocoPhillips (COP) and Apache Corp. (APA) have said they’ll cut their 2015 capital budgets as they tighten their respective belts for oil price pain. Cuts like those can only result in a disaster for companies like Civeo (CVEO), a provider of housing for oil workers in the Canadian oil sands industry.

Gaming this fallout even further means negative pressure on oil industry revenues and earnings. We’ve started to see Wall Street start to catch up and slash oil and energy company expectations, but it’s the commentary on the upcoming earnings conference calls that will tell the tale of how bad things could get in the coming weeks.

Candidly, I’m not all that optimistic we’ll see a big reversal in oil prices in the near term, because all of the data I have been looking at paints a picture of a slowing global economy. If you’re looking to double check my thinking, all you have to do is check in with Dr. Copper – whose second opinion confirms global growth is slowing.

My advice is for you to tighten up your seat belt, as it’s going to get a little bumpy in the coming weeks.

Looking to Get Defensive? Consider Options

Many people tend to think of trading call options as a way to juice their returns as the underlying stock climbs higher. That’s certainly a smart strategy, and it’s one I use in my PowerOptions Trader service. What most new options traders tend to forget is that options also include puts, which allow you to position yourself to take advantage of the underlying security.

For example, from the above oil conversation, if you did your homework and believed the drop in oil prices was going to wreak havoc on Haliburton (HAL) shares, you could buy a put option that becomes more valuable as the price of the underlying stock depreciates relative to the strike price.

Another strategy that I’ve employed several times in PowerOptions Trader when things are looking more than a little dicey market-wise is to trade call options on exchange-traded funds (ETFs) that trade inversely to the market. In other words, when the stock market falls, these ETFs trade higher. Two great examples are ProShares Short Dow30 ETF (DOG), which is the inverse ETF for the Dow jones Industrial Average, and ProShares Short S&P500 ETF (SH), the inverse ETF for the S&P 500. For new options traders, and I know there are plenty of you out there, a call option on an inverse ETFs is a rather plain vanilla trade that allows you to profit in a down market.

If you’re new to trading options or just want to brush up on the subject, be sure to look for my new options video that will be coming at you in the next week or so.

In case you missed it, I encourage you to read my e-letter column from last week about why you should keep your portfolio active.

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